(INDIA) — An assessment guidance article for Indian income-tax Assessing Officers set out a shareholder-focused test for taxing “Deemed Dividend” under Section 2(22)(e), warning that incorrect additions often get deleted at appellate stages.
The ready reckoner describes Section 2(22)(e) of the Income-tax Act, 1961 as an anti-avoidance provision aimed at closely held companies that distribute accumulated profits through loans, advances, or indirect payments instead of declaring taxable dividends.
It frames the central compliance risk in simple terms: tax follows the shareholder of the lending company, not a non-shareholder concern that merely receives funds.
The guidance calls Section 2(22)(e) “one of the most litigated provisions in corporate taxation” and says “Incorrect application frequently results in additions being deleted at appellate stages.”
It positions the document as a structured assessment guide for Assessing Officers (AOs), tax practitioners, and departmental officers, with the stated aim of making additions “legally sustainable” under the deemed dividend rules.
The article describes the legislative purpose as stopping closely held companies from distributing accumulated profits “in the guise of” loans, advances, or indirect payments, rather than by declaring dividends that attract tax.
“In substance, the law treats certain loans as constructive distribution of profits,” it says, tying the concept of deemed dividend to a constructive payout of profits to shareholders.
Before any deeper analysis, it tells Assessing Officers to run a first-level screening in which all basic preconditions must be satisfied, because “Failure of even one condition renders Section 2(22)(e) inapplicable.”
The lending company must be a closely held company, defined in the guidance as “not a company in which the public are substantially interested.” The payment must represent a loan or advance, and it must be made out of accumulated profits.
The recipient must also fall within a specified shareholder-related category, a filter the guide treats as decisive rather than procedural.
From there, the guidance breaks the law’s scope into three operating scenarios, beginning with a loan or advance given directly to a shareholder who holds “10% or more voting power in the lending company.” In that situation, the guide says, the amount is treated as deemed dividend.
A second scenario, described as the “Most Litigated Area,” covers loans or advances given to a “concern,” including “Company,” “Partnership Firm,” “HUF,” “AOP / BOI,” or any concern where a shareholder of the lending company both “holds ≥10% voting power” and “has ≥20% substantial interest in the concern.”
On that second limb, the guide draws a sharp line between conceptual applicability and actual taxability, telling officers that Section 2(22)(e) “becomes applicable, but taxability requires separate examination.”
A third scenario covers any payment made “on behalf of a shareholder” or “for the individual benefit of such shareholder,” which it also treats as deemed dividend.
The core operational instruction for field officers comes next: “Deemed dividend is taxable only in the hands of the shareholder of the lending company.” The guidance adds that officers cannot tax it “in the hands of a non-shareholder concern merely receiving funds.”
It anchors that approach in what it calls an authoritative legal position, listing “CBDT Circular No. 495 dated 22-09-1987” and “CIT v. Ankitech Pvt. Ltd. (Delhi High Court),” and says multiple High Courts nationwide followed it as an accepted departmental position.
To translate that principle into assessment steps, the guide sets out what it calls a mandatory two-step test.
Step 1 is an applicability test. The Assessing Officer must identify “Who is the shareholder holding ≥10% voting power?” and then ask whether that shareholder possesses “≥20% substantial interest in the recipient concern?”
If the answers meet the thresholds, the guide says, Section 2(22)(e) “applies conceptually,” but it warns that this does not end the inquiry.
Step 2 is a taxability test it labels the “Critical Stage,” built around a “decisive question”: “Is the recipient a shareholder of the lending company?”
Where the recipient itself is a shareholder, the guidance marks it “✅ Taxable.” Where the recipient is a “Non-shareholder concern,” it marks it “❌ Not taxable,” and says failure to apply that distinction produces additions that do not survive.
A classic illustration in the guidance aims to show how a transaction can trigger Section 2(22)(e) yet still be taxed in a different set of hands than the recipient.
In the example, “Company A grants a loan to Company B.” “Mr. C” holds “50% shares in Company A” and “50% interest in Company B,” while “Company B holds no shares in Company A.”
The analysis in the example concludes: “Does Section 2(22)(e) apply? YES,” “Is Company B taxable? ❌ NO,” and “Who is taxable? Mr. C (Shareholder).” The document says “The concern merely acts as a conduit for shareholder benefit.”
Beyond entity identification, the guide puts unusual weight on assessment-year sequencing, arguing that an officer can reach the right legal conclusion on deemed dividend and still apply the wrong charge mechanism if the year-specific regime is misread.
It sets out a year-wise taxability framework in which “Correct taxation depends upon the Assessment Year.”
“Up to AY 2018-19,” the guidance says, “Shareholder taxed.” For “AY 2019-20 & AY 2020-21,” it says the “Company liable to DDT u/s 115-O.” From “AY 2021-22 onwards,” it returns to “Shareholder taxed (DDT abolished).”
The guide flags misapplication of that timeline as a recurring field mistake, stating: “Applying the wrong regime is a frequent assessment error.”
A second, expanded version of the ready reckoner presented as updated “as of FY 2025-26” repeats the shareholder-centric approach and says it refines the original framework with “Finance Act 2025 amendments, recent judicial clarifications, and post-DDT abolition rules (effective AY 2021-22).”
That updated portion describes the same core target: closely held companies distributing accumulated profits via loans or advances to substantial shareholders or their concerns, rather than taxable dividends, and it reiterates that the rule applies only to the extent of accumulated profits.
It also refers to *Navnit Lal C Javeri v K.K. Sen* (1965) in describing the provision’s anti-avoidance scope, stating it applies to companies where “≥75% voting power is held by allied non-public groups.”
On accumulated profits, the updated portion describes a measurement approach “up to payment date” and says it includes “commercial profits till distribution, excluding capital gains/losses.” It also sets out a quantitative cap: “Quantum: Limited to accumulated profits; excess loan not deemed dividend (e.g., ₹5L loan with ₹4L profits = ₹4L deemed).”
The same updated text draws a distinction between loans or advances and certain commercial transactions, stating the nature of payment covers loan or advance, and adds “not trade advances in ordinary course,” while also including payments made on behalf of a shareholder.
It tightens the identification of covered recipients by describing the direct shareholder category as a “beneficial owner,” and adds that shares should be “not fixed-rate dividend entitled” for the first limb.
The expanded version also repeats the three-situation structure and includes an illustrative case for direct lending to a shareholder: “ABC Pvt Ltd (closely held, ₹25L profits) loans ₹10L to 15% shareholder Hari via cheque: full ₹10L deemed in Hari’s hands.”
For payments made for the benefit of a shareholder, it lists a non-exhaustive example: “Company pays shareholder’s plant/machinery advance for export order.”
On rates and mechanics in the brief regime table it provides, the updated text states that for “2019-20 to 2020-21,” “Company (DDT u/s 115-O)” applied at “30% + cess/surcharge (company pays).”
It also states that from “2021-22 Onwards” the shareholder bears tax at “Slab rates (DDT abolished 01-04-2020); TDS @10% u/s 194 if >₹5,000 to residents.”
In the same block, the updated version includes a carve-out linked to legislative change, stating: “Finance Act 2025 excludes loans/advances by finance companies/units from deemed dividend.”
The guidance also warns officers not to treat repayment timing as a safe harbour, stating: “Year-end accrual; repayment before FY-end does not exempt (e.g., May loan repaid Dec: still deemed).”
On assessment practice, the original guide lists a set of mistakes officers should avoid, starting with “Taxing recipient company/firm merely because it received funds,” and then “Ignoring the shareholder requirement.” It also warns against “Confusing applicability with chargeability,” a phrase that mirrors its two-step test.
The list includes “Overlooking binding CBDT Circulars under Section 119,” and “Applying post-2020 dividend taxation rules retrospectively,” which aligns with its warning about applying the wrong year-wise regime.
To prevent such outcomes, the guidance sets out a practical checklist for pre-addition verification that mirrors its conceptual architecture.
It tells officers to verify the lending company is closely held, confirm accumulated profits exist, identify the shareholder holding “≥10% voting power,” and establish “≥20%” substantial interest in the recipient concern.
The checklist also instructs officers to ensure the “Correct assessment year taxation regime” applies, and that any addition is “proposed in the hands of the correct taxable person.”
The document compresses its conceptual position into a one-line principle: “A loan to a concern is treated as an indirect benefit given to the shareholder.” It then states the operational result: “Therefore, tax follows the shareholder — not the recipient concern.”
That logic becomes a “Golden Rule for Field Officers,” which the guidance states as: “Section 2(22)(e) imposes shareholder-centric taxation, not recipient-centric taxation.”
As a memory aid, it provides a short decision flow that begins with “Loan or advance given,” asks whether the “Lending company” is closely held, and then tests for a “Common shareholder ≥10% voting power” and “Substantial interest ≥20% in recipient.”
If those conditions point to coverage, the final instruction reads: “Identify shareholder” and “Tax only the shareholder,” reinforcing the core direction to Assessing Officers dealing with Deemed Dividend disputes under Section 2(22)(e).
Deemed Dividend Under Section 2(22)(e) Guides Assessing Officers
The Indian Income-tax Department has issued a structured guide to minimize litigation over ‘Deemed Dividends’ under Section 2(22)(e). The guidance mandates a shareholder-centric approach, ensuring that tax is levied on the actual shareholder rather than non-shareholder concerns receiving funds. It outlines specific thresholds for voting power and substantial interest while providing a year-wise taxability framework to prevent frequent assessment errors by field officers.
